FY 19 growth to be slower than expected; here’s why

Meaningful capex is unlikely before 2020-21, with banks reluctant to lend and India Inc overleveraged.

Meaningful capex spends are unlikely to kick in before 2020-2021. (PTI)

With bond yields spiking and the rupee losing more value every day, India’s macroeconomics is fast deteriorating. The timing is really unfortunate because there are signs of an incipient recovery in the economy; consumption, for instance, has been in fairly good nick. But with loan rates having moved up by 15-20 basis points over the past month—State Bank of India’s marginal cost of funds-based lending rate (MCLR) is now a not-so-low 8.45%—it is hard to see how companies are going to be convinced to borrow much more. Indeed, with much of the government’s borrowings scheduled for the second half of the year, rates are going to rise faster than one could have imagined even three months back. The average yield on corporate bond—across maturities—rose to a near two-and-half-year high of 9.1% in August.

Had banks been armed with a little more capital, and had there been less fear of further delinquencies, they might have been willing to keep loan rates a little lower. But liquidity isn’t as abundant as it should be, going by how the corporate bond markets actually saw negative net issuances in the June quarter, while net flows into equity mutual fund schemes have now decelerated for nearly nine months in a row. The rate of growth of bank deposits has averaged 8% y-o-y in FY19 so far, and there is not much of a base effect since, in no fortnight after August, 2017, has the growth been in double digits.

The fact is that, for several reasons—including what some economists are calling unaffordable indulgence—the pace of savings has been slowing for some time now. This could be a serious structural bottleneck that will hobble the economy, and can be addressed only over a slightly longer period. So far, consumption, as the growth of 8.6% in Q1FY19 shows, is alive and kicking. Some of this may have been driven by the Rs 4.5 lakh crore increase in wages and pensions for nearly 30 million government workers in the last three years, as Neelkanth Mishra at Credit Suisse points out. But, consumption could slow down in the next few quarters for several reasons—higher inflation and stagnating investments, which means not too many jobs will be generated. Economists argue some reining in of consumption is needed at a time when the CAD is widening. It would certainly make sense to curb imported consumption. The trade data for July, for instance, should be a big wake-up call for the government. One reason why the July trade deficit shot up to a five-year high was that non-oil, non-gold imports shot up by 18.4% y-o-y—compared with only 8.4% y-o-y in June and 11.2% y-o-y in May. This was primarily due to a big jump in import of consumer goods, to 9.3% y-o-y. More particularly, import of electronics—India’s fastest-growing imports in recent years—rose 26.4% y-o-y. In the four months to July, this has risen to $18.5 billion, more than a tenth of the goods import bill—something that the government must pay serious thought. At least, in the short term, India may need to clamp down on consumer-goods import, until it is able to create manufacturing capacity for this. An annual saving of $20-25 billion is welcome at a time when portfolio inflows into the bond and equity markets are down to a trickle. While the government could try and boost exports that have been very disappointing, month after month, there is little that can be done in the short term, except to ensure GST refunds are speeded up. The best that can be hoped for is a weaker rupee giving exporters some advantage because several labour-intensive exporting segments have been badly hit.

Meanwhile, meaningful capex spends are unlikely to kick in before 2020-2021. To be sure, the several M&A transactions—including those via the insolvency process—investments; only, they don’t result in fresh capacity being created and nor will they generate new jobs. There are two reasons why investments by the private sector won’t pick up for at least another two years. First, most business groups and promoters simply don’t have the financial wherewithal to contribute to the equity of a project. While, in the good old days, they were able to source the equity contribution from the bank loans, that may no longer be possible. Domestic corporate indebetedness may be falling, but only very gradually; so, banks will remain reluctant to lend. Moreover, corporate profits are expected to grow only modestly, so investible surpluses aren’t going to be big. The second reason is that there is enough capacity going around. There is no evidence to suggest we are going to run short of any goods—or for that matter, services—in the near term. Capacity utilisation may be going up, but, as economists have pointed out, it remains at sub-optimal levels. Corporate earnings show that very few companies have any pricing power, including the top brands. Also, with the government having done very little to relax labour laws, a good chunk of the fresh manufacturing capacity that is set up will be automated. Industry will also be wary of risking big money ahead of the elections. The economy was always expected to lose momentum in the second half of FY19 with the favourable base effect fading away, but it could decelerate more than anticipated. Already, the lower PMI for August suggests domestic demand has moderated, as do the muted GST collections for July. The government will accelerate spending ahead of the general elections in 2019, but it too has fiscal constraints. Even as it has been resorting to extra-budgetary borrowings to fund infrastructure projects, it must be careful not to overshoot the deficit target. The cost of that prudence will, of course, be slower growth—at least in FY19.